From 1 March 2021, the way that VAT is accounted for on some subcontracted construction supplies will change.
Under the historic rules (pre-1 March), a VAT Registered subcontractor would invoice their customer for work carried out and apply VAT to this, which the customer would pay to the subcontractor in full.
The subcontractor would then account for the VAT on their VAT Return. This will change from 1 March.
The new rules will require that, subject to specific criteria, that where a subcontractor is invoicing a customer who is not the ‘end user’ (or linked to an end user) of the supply (i.e. the customer, or “main contractor”, is making an onward supplies of the work to another party), the subcontractor should not charge VAT to that customer.
Instead, the responsibility for accounting for the VAT will apply to the customer, who must account for it on the subcontractors behalf, via their own VAT Return. The subcontractors invoice should make it clear that the supply is subject to reverse charge and that the customer is responsible for accounting for the VAT.
The reverse charge will affect certain specified supplies of building and construction services where those services also need to be reported under CIS (the Construction Industry Scheme).
The reverse charge applies to the whole service whereas CIS only applies to labour (not materials), so quite an important distinction from CIS. It does not apply where the customer (i.e. Main Contractor) is not VAT registered.
The reverse charge also does not apply where the supplies are made directly to an end user (or an intermediary connected with an end user).
These are defined as the “consumers” or “final consumers” of the building and construction services in question, i.e. they are not making onward supplies of the services to someone else.
So, if services were provided directly (for example) to a member of the public on their own home; or a business on their own building; it would not be affected by the reverse charge and the original VAT rules will continue to apply.
If any of the services in a supply are subject to the reverse charge, all other services (even if that service would be excluded if it were being supplied as a single service) must also be subject to it, unless the element subject to reverse charge is 5% or less of the value of the whole contract (in which case the reverse charge can be disregarded).
An example of the change is provided below.
Pre-1/03/21 (historic rules)
- Subcontractor A invoices Main Contractor B for £1,000 + £200 (20%) Output VAT = £1,200 total charge;
- B physically pays £1,200 to A;
- A declares £200 Output VAT on it’s VAT Return and pays this to HMRC;
- B reclaims £200 Input VAT (if entitled to under the normal reclaim rules) on its VAT Return.
From 1/03/21 (new rules)
- Subcontractor A invoices Main Contractor B for £1,000, but as the work is covered by the reverse charge provisions, it transfers responsibility for accounting for the Output VAT to Main Contractor B = £1,000 total charge;
- B physically pays only the net amount of £1,000 to A;
- B declares £200 Output VAT on it’s VAT Return (regardless of whether it can then reclaim it or not) and pays this to HMRC via the VAT Return; A does not declare any Output VAT on its VAT Return in relation to this transaction.
- B reclaims the corresponding £200 Input VAT on it’s VAT Return (if entitled to under the normal reclaim rules) and reclaims this from HMRC, so the two effectively net back to zero on the Return.
Please note that, as is the current position, the Main Contractor is only entitled to reclaim the VAT subject to the normal rules i.e. to the extent that it relates to its own VAT-taxable supplies. The Subcontractor must continue to submit VAT Returns and can continue to claim input VAT on expenditure, subject to the normal rules.
The change will have a detrimental cashflow impact on Subcontractors (i.e. at present they are receiving VAT charged to the Main Contractor and retaining it for up to 3-4 months, until paid over to HMRC via their VAT Return) and a positive cashflow impact on Main Contractors (i.e. at present they are paying over VAT to the Subcontractor and not receiving credit for it for up to 3-4months, until reclaimed from HMRC via their VAT Return). Current invoicing/book-keeping methods may also have to change.
HMRC provide detailed guide and we would suggest that all affected businesses review and consider this carefully. This also provides a helpful summary on when you should check/verify the VAT or CIS status of customers or suppliers.
If you require any clarification on the new rules please do not hesitate to contact us.